Okay, maybe I’m not a Tesco bull, but I’m certainly not a Tesco bailer. I’ve been a shareholder since 2012 and I have no intention of selling in the eye of the hurricane; my contrarian nature would not allow it.
So when it came to writing my latest article for the BullBearnings website I thought I should write about how shareholders could sleep soundly at night, even if they owned Tesco. I have a feeling that almost nobody will agree.
And so to this week’s links, from the wide and varied things I’ve seen on the web this week:
- How to invest in shares and still sleep soundly at night – This BullBearings article is mostly about diversification, slightly about Tesco.
- Article of faith – The price you pay (measured by CAPE in this article) is more important than the growth of earnings and dividends according to the guys at The Value Perspective, and I’m inclined to agree.
- How to use CAPE to beat the market – CAPE is a bit of a long-running obsession of mine. This article looks at Meb Faber‘s work on global CAPE valuations.
- Putting the ‘c’ in “long-term” – Richard Beddard on the relationship between contrarianism and long-term investing.
- There’s no such thing as a risk-free company – Yet more on Tesco, this time from MoneyWeek.
- How many stocks should you own in your portfolio? – I’ve written on this many times and so I’m glad to see that someone else (Ed Croft from Stockopedia) agrees with me for a change, that 10-15 stocks are probably not enough to sufficiently reduce risk for most investors. That’s enough to reduce volatility (i.e. the academic measure of “risk”) but it still leaves you with a high risk of underperforming, which is the risk that most people really care about. A 25-30 stock portfolio is much less likely to underperform, which is what I’ve been saying for a very long time!
You allude to it here, but I was wondering how you really felt about Tesco as an investment now when measured against your entry criteria. I.e., would you buy Tesco now and if not, why not? Also, given that you are not selling, at what point would you take that decision? Was there nothing that would have alerted you to Tesco’s problems sooner so you could have dumped it from your portfolio? I’m no expert. Just curious.
Hi Graham, that’s a very interesting question.
In terms of Tesco’s rank on my stock screen the current problems wouldn’t have affected it at all yet as the dividend cut won’t show up until the next annual results are out. But I do try to sidestep companies where there are current problems which have a significant chance of undermining the company’s long-term ability to generate growing sales, profits and dividends.
So If I were buying something today and Tesco was a top ranking stock (which it is), would I buy? I’m not sure. I think I might be inclined to yes. Although perhaps I might be a little cautious on position size, putting perhaps 3% of my portfolio into it.
Unlike most of the doom mongers I don’t profess to have any idea on where Tesco could be five or ten years from now. They could easily be generating record profits and dividends, in which case their share price would be substantially more than twice what it is now, which in a five to ten year window is a reasonable return. I don’t yet see why the current problems are anything more than the sort of problem that companies face all the time, exacerbated by a macroeconomic environment suited to new competitors (the discounters) and management that were very slow to do anything (i.e. nothing) about it.
As for selling, I will sell as usual primarily based on the company’s rank on my screen, tempered to some degree by qualitative factors, i.e. “gut feel”. Unless Tesco really tanks in a major way (whatever that means) I expect to be holding the shares for a few years yet, unless the share price rockets up, which I don’t expect to happen any time soon.
In terms of spotting these issues before hand, one factor was that free cash flows were not covering the dividend over a period of many years. The gap was being filled with borrowings. While that isn’t necessarily a problem it’s not exactly healthy over long periods of time. So perhaps that would have helped, but sidestepping companies where free cash flow is less than dividends does have an opportunity cost, in that often it’s an irrelevant measure and you could miss out on gains by avoiding such stocks.
I would say let’s revisit this topic in 2020 and we’ll have a better idea of what the right course of action was.
John
You are certainly not the only Tesco bull in town. Sports Direct’s owner Mike Ashley has a £43 million bet on Tesco.
The truth is that we don’t know what’s going to happen to Tesco.
It will probably be fined by the regulator for filling wrong information with the stock exchange and probably sued by investors who like me invested based on those figures. These are costs that are hard to quantify.
I would give Tesco between 6 months to 1 year to see some good news like a small improvement in the margin etc. If not I would move on. I can’t afford to buy shares and forget about them until 2020.
I think and feel that irrespective of what happens with respect to Tesco’s financial misdemeanour’s, it’s not just about recovering face with the financial community and the customers, many of whom feel duped by the pricing tactics.
It’s more to do with structural change!
The Lidl and Aldi’s of this world were fairly under the radar even only 3 years ago. Today they have such a high profile image in the press and the visual media that it’s now ingrained in people’s psyche — most people, rather than a lucky few historically, now know that these companies sell a basket of essential groceries for 40% less than any of the top 4 supermarkets, and their 35% growth in 2013 shows that message has stuck firm.
That tells you that the 3-5% margins enjoyed over the last 20 years are probably consigned to the dustbin.
The game has fundamentally changed along with the margins these companies can hope to earn going forward. The problem is what do they do about the costs, which are largely fixed inside the big sheds that they sell from and the buying power has already squeezed the pips out of the suppliers.
No doubt there will be an element of the stocks being oversold, but something looks and feels like a complete reset to another much lower level.
The advantages the big supermarkets claim like petrol stations, coffee shops and 25,000 items are a red herring, they don’t matter. Neither does on-line shopping which is fundamentally loss making. the German chains have already figured this out and don’t want them.
Hi LR, yes I understand all the points you’re making, but I still prefer hindsight to prognostication!
Time will tell. So far in this country the discounters have been left untouched. But now Morrisons is going after them directly, and perhaps Sainsbury’s and Tesco will to. Then we’ll have a better idea of how this fight will pan out.
Hi John, The term discounters is inappropriate, given that Aldi and Lidl don’t discount, they sell at face value and at much lower prices (typically 40% less) than the big 4 for the same and often better quality.
Sainsbury has a 3% margin
Tesco has a 4.5% margin, but they have been telling porkies so it’s probably a lot less.
Aldi made £260M on £5.2Bn turnover (a 35% increase) in 2013 alone and that represents 5%.
Aldi have pledged to keep prices at the same level below the big 4 so there will only be one loser here. If Sainsbury slashes it’s margins by 50% it still can’t compete with Aldi unless it simply closes a lot of lines and space.
The game has changed and there is unlikely to be a mean reversion effect here.
As the stocks have almost hit capitulation point today with SBRY falling 6.64% as I type and Tesco languishing at a 12 year low and down another 3.38%, the penny has dropped with the majority of investors.
There will be a bottom to these share prices, but I couldn’t guess at what it will be.
I hate to admit it but Neil Woodford had the vision to see this coming.
LR, you are right, on an average basket of £53, Tesco is loosing money on home deliveries. The only company that makes money on home deliveries is Ocado, as their average basket is £118. Ocado’s margin is around 5% and as they say it they don’t have the ‘buying power’ of others but they have managed to save money from a better organisation in their fulfilment centres.
The Germans have the advantage of cheaper food brought from Europe, but this is something that Tesco could easily copy. Not only this but there is a high pressure on the British food producers to compete with cheaper prices. The price of milk is already 40% down at the farm gate from last year. You could well expect roads blockages from UK farmers by Christmas.
As the leader supermarket Tesco could easily compete in this and maintain a margin.
There are other issues too. European food sold in UK is cheaper but poor quality. For one day Tesco may change its advertising and say that ‘their burgers have more MEAT in them than Aldi’s’.
Myself I am fairly confident in a turn around. Rapid expansion could also be a strain for the Germans too. Lidl opens shops from Qatar to Russia or UK by borrowing money. If the margins don’t come through, that could be a big problem.
Folks, could not help but join the discussion. I don’t really have a firm view on Tesco valuation but having looked over their cash flow for the last five years this is a complete disaster. They have basically spent over 16bn in that peiord on capex while the operating cash flow dropped from 4.7bn to 2.8bn – there wasn’t even enough cash in the register to pay dividends wihtough raising additinal financig.
So, I don’t really have any prognosis but based on what seems like negative returns on additional invested capital I don’t see an easy investment case here… I wish management good luck with the turnaround – it won’t be easy.
more on the cash flow story here:
http://www.valueinvestorshouse.com/a-short-story-on-tesco/